WellPoint's Big Surprise Isn't So Surprising

Thanks to lower health care costs and surging Medicaid enrollment, WellPoint (WLP) joined United Healthcare (UNH), and Aetna (AET) in reporting solid first-quarter results.

May 2, 2014 at 2:05PM

Qualifying for Medicaid has gotten easier, and big insurers are clapping their hands over it. That's because many of the largest state Medicaid plans aren't run by the states, but by private insurance companies like WellPoint (NYSE:ANTM), United Healthcare (NYSE:UNH), and Aetna (NYSE:AET).

Those mega insurers, along with a handful of smaller niche insurance companies, bid for the right to manage those Medicaid plans. And since those bids are based on the number of people enrolled in Medicaid, the millions of new members that have signed up for the program since Obamacare kicked in last fall have been a boon to insurers' top and bottom lines.

So, it shouldn't be too surprising to learn that WellPoint has joined United and Aetna in reporting impressive results for its Medicaid business. Yet investors appear to have been caught flat-footed given shares jumped to new highs following the earnings release. Since shares have soared, lets take a closer look at WellPoint's quarter and better understand why investors have rushed back in.

WLP Chart

WLP data by YCharts.

Understanding WellPoint's business
The company provides insurance to people in exchange for insurance premiums. Like most insurers, it uses sophisticated models to price premiums high enough to pay for its members' health care, its operating costs, and -- of course -- its profit.

If members use less health care services in any given quarter, the insurer makes more money. If they use more health care services in any given quarter, the insurer makes less money. As long as the model prices for the costs of care, each additional member's premium should boost revenue and the insurer's profit.

Of course, that makes a big assumption. It assumes the model works correctly. And that's the one risk that was keeping investors awake at night. Because if these plans weren't priced right, and the cost of providing care exceeded what was expected, profit would nosedive.

So far, that fear appears off-base.

Both United and Aetna had already reported earnings that were either at (in the case of United) or far above (as was the case for Aetna) Wall Street analyst estimates.

And now, with WellPoint having also reported earnings that were above expectations, investors have additional conviction that reform won't impale insurer profit this year.

WellPoint added 1.3 million new members during the quarter, bringing its total membership to nearly 37 million people. That gave the company enough faith to increase its full-year EPS guidance from "above $8" per share at the end of January, to "greater than $8.40" today.

Behind the numbers
The bulk of WellPoint's new members came from the national, local, and group markets. Those 1.2 million new members helped WellPoint's total operating revenue grow a bit more than 1% to $17.6 billion in the first quarter.

However, that 1% figure masks much stronger results from the company's Government business, which includes Medicaid.

The company added more than 120,000 new Medicaid members in the quarter, which boosted WellPoint's Government business revenue by nearly 5% from a year ago.

That solid showing reinforces success at WellPoint's competitors. United Healthcare's Medicaid revenue grew 17% to $5.2 billion as Medicaid enrollment grew by 255,000. And Aetna's acquisition of Coventry Health last May, and Medicaid expansion, helped its government premiums grow from $2.6 billion to $5.1 billion in the quarter.

However, membership growth is only one side of the coin. Insurers also need costs to remain in check to make money, and WellPoint looks good there, too.

The company's benefit expense ratio, which shows how much the company paid out to provide health care to its members relative to the premiums it collected from those members, fell 1% from last year to 82.7%.

The company attributes that success to better performance from the company's Medicaid business, which saw its operating margin leap from 1.4% last year to 3% in the first quarter.

A combination of solid revenue and lower health care costs fueled WellPoint's repurchase of nearly 5% of its shares outstanding, or roughly 14.3 million shares. And WellPoint was still able to bulk up its cash position, which finished the quarter at $1.97 billion, up from $1.58 billion last year, despite those buybacks.

Fool-worthy final thoughts
The biggest takeaway from WellPoint's quarter may be that the company feels confident enough to boost its guidance for its full-year results.

That gives investors confidence that it will continue its shareholder-friendly buybacks, and more importantly, maintain or grow its healthy dividend, which currently stands at $1.75 per share per year. Given that backdrop, it would seem investors' recent enthusiasm isn't misplaced.

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Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned.The Motley Fool recommends UnitedHealth Group and WellPoint. The Motley Fool owns shares of WellPoint. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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